[Federal Register Volume 77, Number 113 (Tuesday, June 12, 2012)]
[Rules and Regulations]
[Pages 34785-34788]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-14226]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9592]
RIN 1545-BK86
Substantial Business Activities
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Temporary Regulations.
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SUMMARY: This document contains temporary regulations regarding whether
a foreign corporation has substantial business activities in a foreign
country. These regulations affect certain domestic corporations and
partnerships (and certain parties related thereto), and foreign
corporations that acquire substantially all of the properties of such
domestic corporations or partnerships. The text of these temporary
regulations serves as the text of the proposed regulations set forth in
the notice of proposed rulemaking on this subject also published in
this issue of the Federal Register.
DATES: Effective Date: These regulations are effective on June 12,
2012.
Applicability Date: For date of applicability, see Sec. 1.7874-
3T(f).
FOR FURTHER INFORMATION CONTACT: Mary W. Lyons, (202) 622-3860 and
David A. Levine, (202) 622-3860 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On June 6, 2006, temporary regulations under section 7874 (TD 9265,
2006-2 CB 1) were published in the Federal Register (71 FR 32437)
concerning the treatment of a foreign corporation as a surrogate
foreign corporation (2006 temporary regulations). A notice of proposed
rulemaking (REG-112994-06) cross-referencing the 2006 temporary
regulations was published in the same issue of the Federal Register (71
FR
[[Page 34786]]
32495, 2006-2 CB 47). On July 28, 2006, Notice 2006-70 (2006-2 CB 252)
was published, announcing a modification to the effective date
contained in the 2006 temporary regulations. See Sec.
601.601(d)(2)(ii)(b). On June 12, 2009, the 2006 temporary regulations
and the related notice of proposed rulemaking were withdrawn and
replaced with new temporary regulations (2009 temporary regulations),
which generally applied to acquisitions completed on or after June 9,
2009. TD 9453 (74 FR 27920, 2009-2 CB 114). A notice of proposed
rulemaking (REG-112994-06) cross-referencing the 2009 temporary
regulations was published in the same issue of the Federal Register (74
FR 27947, 2009-2 CB 144). No public hearing was requested or held;
however, comments were received. All comments are available at
www.regulations.gov or upon request. After consideration of the
comments received regarding whether a foreign corporation has
substantial business activities in a foreign country, the Internal
Revenue Service (IRS) and the Department of the Treasury (Treasury
Department) have decided to issue new temporary regulations under Sec.
1.7874-3T (2012 temporary regulations) and a new notice of proposed
rulemaking that provide guidance regarding this determination. The
other portions of the 2009 temporary regulations are finalized in a
separate Treasury Decision published elsewhere in this issue of the
Federal Register.
Explanation of Provisions
A. General Approach
A foreign corporation is generally treated as a surrogate foreign
corporation under section 7874(a)(2)(B) if pursuant to a plan (or a
series of related transactions): (i) The foreign corporation completes
after March 4, 2003, the direct or indirect acquisition of
substantially all of the properties held directly or indirectly by a
domestic corporation; (ii) after the acquisition at least 60 percent of
the stock (by vote or value) of the foreign corporation is held by
former shareholders of the domestic corporation by reason of holding
stock in the domestic corporation; and (iii) after the acquisition, the
expanded affiliated group that includes the foreign corporation does
not have substantial business activities in the foreign country
(relevant foreign country) in which, or under the law of which, the
foreign corporation is created or organized, when compared to the total
business activities of the expanded affiliated group. Similar
provisions apply if a foreign corporation acquires substantially all of
the properties constituting a trade or business of a domestic
partnership.
The 2006 temporary regulations provided that the determination of
whether the expanded affiliated group has substantial business
activities in the relevant foreign country is based on all the facts
and circumstances. The 2006 temporary regulations also provided a safe
harbor, which generally was satisfied if at least ten percent of the
employees, assets, and sales of the expanded affiliated group were in
the relevant foreign country. The 2009 temporary regulations retained
the facts and circumstances general rule provided in the 2006 temporary
regulations, with certain modifications, but removed the safe harbor.
The IRS and the Treasury Department received comments requesting
additional guidance on the level of business activities necessary for
an expanded affiliated group to have substantial business activities in
the relevant foreign country. One comment suggested providing a new
safe harbor, which would require a higher percentage of business
activities in the relevant foreign country than was required under the
safe harbor included in the 2006 temporary regulations. The comment
also recommended different safe harbors depending on the extent of the
expanded affiliated group's business activities in the United States.
After consideration of the comments and the underlying policies of
section 7874, the IRS and the Treasury Department believe the facts and
circumstances test of the 2009 temporary regulations should be replaced
with a bright-line rule describing the threshold of activities required
for an expanded affiliated group to have substantial business
activities in the relevant foreign country. The IRS and the Treasury
Department believe that such a rule will provide more certainty in
applying section 7874 to particular transactions than the 2009
temporary regulations and will improve the administrability of this
provision.
B. Threshold of Business Activities
The 2012 temporary regulations provide that an expanded affiliated
group will have substantial business activities in the relevant foreign
country only if at least 25 percent of the group employees, group
assets, and group income are located or derived in the relevant foreign
country, determined as follows:
1. Group Employees
The 2012 temporary regulations set forth two tests, each of which
must be satisfied, based on employees of members of the expanded
affiliated group (group employees). The first test is calculated as the
number of group employees based in the relevant foreign country divided
by the total number of group employees determined on the applicable
date discussed in section B.4. of this preamble. The second test is
calculated as employee compensation with respect to group employees
based in the relevant foreign country divided by the total employee
compensation with respect to all group employees determined during the
one-year testing period.
2. Group Assets
The group assets test is calculated as the value of the group
assets located in the relevant foreign country divided by the total
value of all group assets determined on the applicable date. The term
group assets generally means tangible personal property or real
property used or held for use in the active conduct of a trade or
business by members of the expanded affiliated group. For this purpose,
group assets include certain property rented by members of the expanded
affiliated group, with the value of such rented property being deemed
to be eight times the net annual rent paid or accrued with respect to
such property. The IRS and the Treasury Department believe that using
an eight-times multiple for this purpose is administrable and
consistent with the treatment of rented property for other purposes.
See, for example, Uniform Division of Income for Tax Purposes Act,
Sec. Sec. 10 and 11. In order to constitute group assets, such rented
property must satisfy the other applicable requirements for group
assets, including that the property is used or held for use in the
active conduct of a trade or business.
3. Group Income
The group income test is calculated as the group income derived in
the relevant foreign country divided by the total group income
determined during the one-year testing period. The term group income
means gross income of members of the expanded affiliated group from
transactions occurring in the ordinary course of business with
customers that are not related persons. Group income is considered to
be derived in a foreign country only if the customer is located in such
country.
[[Page 34787]]
4. Applicable Date
Section 7874(a)(2)(B)(iii) provides that the determination of
whether the expanded affiliated group has substantial business
activities is made after the acquisition. However, the IRS and the
Treasury Department believe that when the acquisition occurs other than
at the end of a month the factors used to determine whether the
substantial business activities test is satisfied may not be readily
determinable in some cases. Accordingly, the 2012 temporary regulations
provide that the number of group employees and the value of group
assets can be measured as of the applicable date, which is either the
date on which the acquisition is completed or the last day of the month
immediately preceding the month in which the acquisition is completed.
The applicable date is also used to determine the testing period, which
is used in computing group income and employee compensation. When the
applicable date is the last day of the month immediately preceding the
month in which the acquisition is completed, group employees, employee
compensation, group assets, and group income consist of those items or
amounts of members that comprise the expanded affiliated group
determined at the close of the acquisition date.
C. Attribution From a Partnership
The 2009 temporary regulations provided that for purposes of the
substantial business activities test, a member of an expanded
affiliated group that holds at least a ten-percent capital and profits
interest in a partnership takes into account its proportionate share of
all items of the partnership. The IRS and the Treasury Department
believe that the policies of section 7874 are better advanced if the
treatment of partnerships is made consistent with that of corporations
for purposes of applying the substantial business activities test on a
group basis. Accordingly, the 2012 temporary regulations provide that
the items of a partnership should be taken into account for this
purpose only if one or more members of the expanded affiliated group
holds, in the aggregate, more than 50 percent (by value) of the
interests in the partnership. The IRS and the Treasury Department
further believe that, consistent with the treatment of corporations, if
this ownership requirement is satisfied, then all the items of the
partnership should be taken into account for this purpose.
D. Effective Date
Subject to a transition rule, the 2012 temporary regulations apply
to acquisitions completed on or after June 7, 2012.
Special Analyses
It has been determined that that these temporary regulations are
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It also has
been determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) does not apply to the 2012 temporary regulations
and because the regulations do not impose a collection of information
on small entities, the requirements of the Regulatory Flexibility Act
(5 U.S.C. chapter 6) do not apply. Accordingly, a regulatory
flexibility analysis is not required. Pursuant to section 7805(f) of
the Code, the 2012 temporary regulations have been submitted to the
Chief Counsel for Advocacy of the Small Business Administration for
comment on their impact on small business.
Requests for Comments
The IRS and the Treasury Department are considering to what extent
partners of a partnership should be treated as if they were employees
solely for purposes of the two tests based on group employees, and
specifically request comments on these issues. For information on how
to submit comments or request a public hearing, see the section
``Comments and Requests for a Public Hearing'' set forth in the notice
of proposed rulemaking published elsewhere in this issue of the Federal
Register.
Drafting Information
The principal authors of the 2012 temporary regulations are Mary W.
Lyons and David A. Levine of the Office of Associate Chief Counsel
(International). However, other personnel from the IRS and the Treasury
Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.7874-3T is also issued under 26 U.S.C. 7874(c)(6) and
(g).* * *
0
Par. 2. Section 1.7874-3T is added to read as follows:
Sec. 1.7874-3T Substantial business activities (temporary).
(a) Scope. This section provides rules regarding whether a foreign
corporation has substantial business activities in the relevant foreign
country when compared to the total business activities of the expanded
affiliated group for purposes of section 7874(a)(2)(B)(iii). Paragraph
(b) of this section sets forth the threshold of business activities
that constitute substantial business activities. Paragraph (c) of this
section describes certain items not to be taken into account as located
or derived in the relevant foreign country. Paragraph (d) of this
section provides definitions and certain rules of application.
Paragraph (e) of this section provides rules regarding the treatment of
a partnership in which one or more members of an expanded affiliated
group own an interest. Paragraph (f) of this section provides the dates
of applicability and expiration.
(b) Threshold of business activities. The expanded affiliated group
will have substantial business activities in the relevant foreign
country after the acquisition when compared to the total business
activities of the expanded affiliated group only if, subject to
paragraph (c) of this section, each of the tests described in
paragraphs (b)(1) through (b)(3) of this section is satisfied.
(1) Group employees--(i) Number of employees. The number of group
employees based in the relevant foreign country is at least 25 percent
of the total number of group employees on the applicable date.
(ii) Employee compensation. The employee compensation incurred with
respect to group employees based in the relevant foreign country is at
least 25 percent of the total employee compensation incurred with
respect to all group employees during the testing period.
(2) Group assets. The value of the group assets located in the
relevant foreign country is at least 25 percent of the total value of
all group assets on the applicable date.
(3) Group income. The group income derived in the relevant foreign
country is at least 25 percent of the total group income during the
testing period.
(c) Items not to be considered. The following items are not taken
into account in the numerator, but are taken into account in the
denominator, for each of the tests described in paragraphs (b)(1)
through (b)(3) of this section:
[[Page 34788]]
(1) Any group assets, group employees, or group income attributable
to business activities that are associated with properties or
liabilities the transfer of which is disregarded under section
7874(c)(4).
(2) Any group assets or group employees located in, or group income
derived in, the relevant foreign country as part of a plan with a
principal purpose of avoiding the purposes of section 7874.
(3) Any group assets or group employees located in, or group income
derived in, the relevant foreign country if such group assets or group
employees, or the business activities to which such group income is
attributable, are subsequently transferred to another country in
connection with a plan that existed at the time of the acquisition
described in section 7874(a)(2)(B)(i).
(d) Definitions and application of rules. The following definitions
and rules apply for purposes of this section:
(1) The term acquisition date means the date on which the
acquisition described in section 7874(a)(2)(B)(i) is completed.
(2) The term applicable date means either of the following dates,
applied consistently for all purposes of this section:
(i) The acquisition date; or
(ii) The last day of the month immediately preceding the month in
which the acquisition described in section 7874(a)(2)(B)(i) is
completed.
(3) The term employee compensation means all amounts incurred by
members of the expanded affiliated group that directly relate to
services performed by group employees (including, for example, wages,
salaries, deferred compensation, employee benefits, and employer
payroll taxes). Employee compensation is determined in U.S. dollars
translated, if necessary, using the weighted average exchange rate (as
defined in Sec. 1.989(b)-1) for the testing period.
(4) The term expanded affiliated group means the affiliated group
defined in section 7874(c)(1) determined at the close of the
acquisition date. The term member of the expanded affiliated group
means an entity included in the expanded affiliated group. A reference
to a member of the expanded affiliated group includes a predecessor
with respect to such member.
(5) The term group assets means tangible personal property or real
property used or held for use in the active conduct of a trade or
business by members of the expanded affiliated group, provided such
property is owned by members of the expanded affiliated group at the
close of the acquisition date. A group asset is considered to be
located in the relevant foreign country only if the asset was
physically present in such country at the close of the acquisition date
and for more time than in any other country during the testing period.
All group assets must be valued consistently and on a gross basis (that
is, not reduced by liabilities) using either the adjusted tax basis or
fair market value determined in U.S. dollars translated, if necessary,
at the spot rate determined under the principles of Sec. 1.988-
1(d)(1), (2), and (4). Tangible personal property or real property that
is rented by members of the expanded affiliated group from a person
other than a member of the expanded affiliated group is also treated as
a group asset, provided such property is used in the active conduct of
a trade or business and is being rented by members of the expanded
affiliated group at the close of the acquisition date. For purposes of
this section, a group asset that is rented is valued at eight times the
net annual rent paid or accrued with respect to the property by members
of the expanded affiliated group.
(6) The term group employees means employees of members of the
expanded affiliated group. A group employee is considered to be based
in the relevant foreign country only if the employee spent more time
providing services in such country than in any other single country
during the testing period.
(7) The term group income means gross income of members of the
expanded affiliated group from transactions occurring in the ordinary
course of business with customers that are not related persons. Group
income is translated into U.S. dollars, if necessary, using the
weighted average exchange rate (as defined in Sec. 1.989(b)-1) for the
testing period. Group income is considered derived in the relevant
foreign country only if it is derived from a transaction with a
customer located in such country.
(8) The term net annual rent means the annual rent paid or accrued
with respect to property, less any payments received or accrued from
subleasing such property (or other similar arrangement).
(9) The term related person has the meaning specified in section
954(d)(3), except that section 954(d)(3) is applied by substituting
``one or more members of the expanded affiliated group'' for ``a
controlled foreign corporation'' and ``the controlled foreign
corporation'' each place they appear.
(10) The term relevant foreign country means the foreign country in
which, or under the law of which, the foreign corporation was created
or organized.
(11) The term testing period means the one-year period ending on
the applicable date.
(e) Treatment of partnerships. For purposes of this section, if one
or more members of the expanded affiliated group own, in the aggregate,
more than 50 percent (by value) of the interests in a partnership, such
partnership will be treated as a corporation that is a member of the
expanded affiliated group. Thus, all items of such a partnership are
taken into account for purposes of this section. No items of a
partnership are taken into account for purposes of this section unless
the partnership is treated as a member of the expanded affiliated group
pursuant to this paragraph.
(f) Effective/applicability and expiration dates. Except as
otherwise provided in this paragraph, this section shall apply to
acquisitions that are completed on or after June 7, 2012. For
acquisitions completed on or after June 7, 2012 that were either
described in a filing with the Securities and Exchange Commission on or
before June 7, 2012, or that were subject to a written agreement that
was binding on June 7, 2012, and at all times thereafter, taxpayers may
apply either the rules in Sec. 1.7874-2T(g), as contained in 26 CFR
part 1 revised as of April 12, 2012, or the rules set forth in this
section. The applicability of this section expires on June 5, 2015.
Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
Approved: June 4, 2012.
Emily S. McMahon,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2012-14226 Filed 6-7-12; 4:15 pm]
BILLING CODE 4830-01-P